Investors often like to see that the sponsor is co-investing along with them and putting their own money at stake. Having skin in the game demonstrates that the sponsor has faith in the deal. Sponsors will usually put in 5-10% of the investment. However, you can imagine that if a sponsor is doing a good number of deals, putting 10% in every deal might be untenable.

Conservative Underwriting

Are they conservative enough?

Another thing you want to look for in a sponsor is conservative underwriting. It helps to first understand things like Internal Rate of Return and Equity Multiples. Ideally, you want someone who will under-promise and over-deliver. You don’t want the old bait and switch. It’s great if sponsors can provide sensitivity tables or analysis. These are different models and projections that are affected by four key variables: vacancy, rent, interest rates, and cap rates. These variables can drastically change your returns. So it’s nice to look at how more conservative assumptions might affect returns, but also at the potential upside.

Sponsor Compensation and Fees

What kind of fees are part of their deal?

When it comes down to it, sponsors usually require compensation in one of two ways:

1️⃣Compensation regardless of performance – encourages operators to just do more deals

2️⃣Performance-based compensation, another name for a “promote” or carried interest – feels more aligned, but also may encourage risk-taking

There are pros and cons to both types. The goal is for the sponsors and investors to be as aligned as possible. This is active management and strategy. In this case, you often get what you pay for.

Acquisition or Organizational Fee

• Earned upon closing of the property. The justification for this fee is that sponsors will see many deals before closing and settling on one. They’ll have spent a significant amount of time and resources on evaluation and cost analysis at their own risk.

• Also, some of the performance or co-investment returns aren’t paid until the deal is closed, which could be 5-7 years down the road. It’s sometimes said that these fees keep the sponsor’s lights on.

• This fee is usually a small percentage of the purchase price of the property – typically 1-2%, but can be slightly higher for smaller deals because the overall dollar amount is lower.

Financing or Loan Fees

• Fees related to figuring out financing and refinancing

• Can be 0.5-1%

Equity or Equity Placement Fees

• Paid to an internal or external team for raising funds

• Usually 2-3%

Asset Management Fee

• To reimburse the sponsor for overseeing management and making sure they’re in line with their projections and business plan

• Usually 1-3%

Construction Fee

• Some sponsors charge this fee if the deal includes a significant amount of renovation or development. Sponsors spend a significant amount of time acting as project managers overseeing the contractors and vendors. I’ve seen this hover around 3-5% of hard construction costs.

Expense Reimbursements

• Simply reimbursement for expenses pre-paid by the sponsors

• Some examples are legal, due diligence including reports, etc

Promote or Hurdles

• This is essentially a bonus for hitting certain incentives

• Example: 20% over an 8% IRR Hurdle and 35% over a 16% IRR Hurdle

• There might be incentive-based fee for hitting certain markers when they refinance. For example, if the sponsors hit a certain refinance amount and are able to get a significant amount of capital return for their investors, the sponsors might get a small bonus.

• Usually 1-2%

Disposition Fee

• For all of the work involved with selling the property

• Around 1%

Fees aren’t everything, but it’s important to take them into consideration to understand how the sponsor operates. Again, the lowest fees don’t always mean the best sponsor. It’s important to know what the fees are for. At the end of the day, if you’re happy with the returns, then the fees are just the cost of doing business. Understanding fees vs. promotes will also give you a good idea of what the incentives are for the sponsor and how they operate.

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